CPI will remain sticky in 2009 due to business models

The Numbers
CPI April 2009: (year over year) 8.4% vs 8.5% in March
CPI April 2009: (month over month) 0.5% vs 1.3% in March

Introduction
At 8.4% the increase in the CPI for April remained sticky.

From the numbers it is clear that economic theory of demand and supply has little impact on the price determination process. For example, a severe contraction in economic production such as in Q1 2009 (the actual GDP numbers show a contraction of -6.8% between Q4 2008 and Q1 2009) should have contributed to a more pronounced slowdown in price increases.

However, the combined impact of:
• South Africa’s capacity shortages (e.g. sharp increases in electricity tariffs);
• The weakening of the rand exchange rate during the last quarter of last year; and
• The business models of South African companies whereby cost increases absorbed in the previous year are passed through in subsequent years,
will contribute to inflation remaining sticky during the course of this year.

Analysis

Big four

The CPI of the BIG FOUR, with a combined weight of 50.34% in the CPI basket, receded further to 7.8% (see Table 1). This is mainly as a result of smaller (yet still high) increases in the prices of food and non-alcoholic beverages (NAB). The CPI of the remaining items increased by 8.9%.

Though the increase in the prices of food and non-alcoholic beverages receded markedly in March and April, it was mainly due to a high base of calculation which occurred in March last year. The lower increase should thus not be interpreted as a slowdown in price increases notwithstanding the slightly slower month over month increases. Eliminating decimals, the month over month increase was still 0.5%.

Another reason for the increase in the CPI of the Big Four remaining high can be attributed to price increases of motor vehicles. This is another indication of the unique South African business model phenomenon – price increases despite huge drops in sales.

Interest rate sensitive inflation

The driver behind the increase in CPI switched from non-interest rate sensitive inflation to interest rate sensitive inflation. The interest rate sensitive CPI increased from 7.7% in January to 8.6% in April whereas non-interest rate sensitive CPI slowed from 8.9% to 7.9% over the same period. Under normal circumstances this would be attributed to strong demand. However, with demand very weak, cost push factors such as increases in electricity tariffs, a weaker exchange rate (compared to the beginning of last year) and the delayed impact of high commodity prices are keeping prices at higher levels.

The impact of the South African business model is again evident in the price increases. Though more than a 1 000 restaurants closed, the restaurant CPI increased from 12.8% in January to 13.3% in April. Also, the recreational and cultural CPI, which reflects price changes in nonessential items and services, was 14.9% in April – indicating that companies will rather increase prices to compensate for losses opposed to reducing prices to increase demand.

Interest rates

As CPI is driven by cost push rather than demand driven factors, another reduction of 100 basis points in interest rates should be announced tomorrow. This should buffer the economic slowdown and not induce more pronounced inflation.